ANNEXURE III BASEL III – CAPITAL REGLULATIONS
4. Capital charge for Credit Risk
RBI has identified external credit rating agencies that meet the eligibility criteria specified under the revised Framework. Banks are required to choose the external rating agencies identified by RBI for assigning risk weights for capital adequacy purposes as per the mapping furnished in the Basel III guidelines.
Claims on Domestic Sovereigns (standard Assets)
(e) Both fund based and non fund based claims on the Central Government including Central Govt. guaranteed claims carry zero risk weight.
(f) Direct Loans/credit/overdraft exposure, if any, of banks to State Govt. and investment in State Govt.
securities carry zero risk weight. State Government guaranteed claims will attract 20 per cent risk weight’.
(g) Risk weight applicable to Central Govt. exposure would also apply to claims on RBI, CGTMSE, and Credit Risk Guarantee Fund Trust for Low Income Housing (CRGFTLIH). The claims on ECGC will attract a risk weight of 20%.
(h) ‘Amount Receivable from GOI’ under Agricultural Debt Waiver Scheme 2008 is to be treated as claim on GOI and attract zero risk weight whereas the amount outstanding in the accounts covered by the Debt Relief Scheme shall be treated as a claim on the borrower and risk weighted as per the extant norms.
Claims on Foreign Sovereigns
Claims on Foreign Sovereigns in foreign currency would be as per the rating assigned as detailed in the RBI circular. In case of claims dominated in domestic currency of Foreign Sovereign met out of the resources in the same currency, the zero risk weight would be applicable.
Claims on Public Sector Entities (PSE)
Claims on domestic PSEs and Primary Dealers (PD) would be risk weighted in the same manner that of corporate and foreign PSEs as per the rating assigned by foreign rating agencies as detailed in the Circular.
Other claims
– Claims on IMF, Bank for International Settlements (BIS), and eligible Multilateral Development Banks (MDBs) evaluated by the BCBS will be treated similar to claims on scheduled banks at a uniform 20%
risk weight. Similarly, claims on the International Finance Facility for Immunization (IFFIm) will also attract a twenty per cent risk weight
– Claims on Banks incorporated in India and Foreign Banks’ branches in India, the applicable risk weight is detailed in the RBI Master Circular.
– Banks’ investment in capital instruments of other banks such investments would not be deducted, but would attract appropriate risk as detailed in the RBI M. Circular.
– Claims on corporate Asset Finance Companies (AFCs) and Non-Banking Finance Companies- Infrastructure Finance Companies (NBFC-IFC),shall be risk weighted as per the ratings assigned by the rating agencies registered with the SEBI and accredited by the RBI (Detailed in the Circular).
– The claims on non-resident corporate will be risk weighted as per the ratings assigned by international rating agencies.
– Regulatory Retail claims (both fund and non-fund based) which meet the Qualifying criteria, viz.
(h) Orientation Criterion: Exposure to individual person/s or to a small business (Average annual turnover less than` 50 crore for last 3 years in case of existing or projected turnover in case of new units);
(i) Product Criterion: Exposure (both fund-based and non fund-based) in form of revolving credits and lines of credit (incl. overdrafts), term loans & leases (e.g. instalment loans and leases, student and educational loans) and small business facilities and commitments
(j) Granularity Criterion – Sufficient diversification to reduce the risk portfolio; and
(k) Low value of individual exposures - The maximum aggregated retail exposure to one counterpart should not exceed the absolute threshold limit of` 5 crore.
Would attract risk weight of 75% except NPAs. As part of the supervisory review process, the RBI would also consider whether the credit quality of regulatory retail claims held by individual banks should warrant a standard risk weight higher than 75%.
– The RWA on claims secured by mortgage of residential properties would be as under:-
Category of Loan LTV Ratio (%) Risk Weight (%)
(a) Individual Housing Loans
(i) Up to` 20 lakh 90 50
(ii) Above` 20 lakh and up to` 75 lakh 80 50
(iii) Above`75 lakh 75 75
(b) Commercial Real Estate - ResidentialHousing (CRE-RH) N/A 75
(c) Commercial Real Estate (CRE) N/A 100
Note: 1. The LTV ratio should not exceed the prescribed ceiling in all fresh cases of sanction. In case the LTV ratio is currently above the ceiling prescribed for any reasons, efforts shall be made to bring it within limits.
2. Banks’ exposures tothird dwelling unit onwards to an individual will also be treated as CRE exposures.
– Restructured housing loans should be risk weighted with an additional risk weight of 25% to the risk weights prescribed above.
– Loans / exposures to intermediaries for on-lending will not be eligible for inclusion under claims secured by residential property but will be treated as claims on corporate or claims included in the regulatory retail portfolio as the case may be.
– Investments in mortgage backed securities (MBS) backed by exposures will be governed by the guidelines pertaining to securitisation exposures (as detailed in the RBI Cir.)
Non-performing Assets (NPAs)
The risk weight in respect of the unsecured portion of NPA (other than a qualifying residential mortgage loan), net of specific provisions (including partial write-offs), shall be:-
Specific Provisions Risk Weight % Less than 20% of outstanding 150
At least 20% of outstanding 100 At least 50% of outstanding 50
– The risk weight applicable for secured NPA is 100%, net of provisions when provisions reach 15% of the outstanding amount.
– NPA Home Loan claims secured by residential property, the risk weight shall be 100% net of specific provisions. In case the specific provisions are at least 20% but less than 50% of the outstanding, the risk weight shall be 75% (net of specific provisions) and specific provisions are 50% or more the applicable risk weight is 50%.
Other specified categories
Category Risk Weight
(%)
01. Venture capital 150 or higher
02. Consumer credit including personal loans, credit card receivables, but excl. 125 educational loan
03. Capital market exposure 125
04. Investment in capital instruments of NBFC 125
05. The exposure to equity instruments issued by NBFCs 250
05. Investment in paid up equity of non-financial entities (other than subsidiaries) where 1251111 investment is below 10% of equity of investee entity.Above 10%
06. Staff loans backed fully by superannuation benefits and/or mortgage of flat/house 20 07. Other loans and advances to staff eligible for inclusion under retail portfolio 75
08. All other assets 100
09. Off balance sheet items (Market related and non-market related items) As detailed in the RBI Circular.
10. Securitization Exposure As per Cir.
Based on rating by external credit agency
11. Commercial real estate (MBS backed) -do-
Definitions and general terminology Counterparty Credit Risk (CCR)
CCR is the risk that the counterparty to a transaction could default before the final settlement of the transaction’s cash flows.
Securities Financing Transactions (SFTs)
SFTs are transactions such as repurchase agreements, reverse repurchase agreements, security lending and borrowing, collateralised borrowing and lending (CBLO) and margin lending transactions, where the value of the transactions depends on market valuations and the transactions are often subject to margin agreements.
Hedging Set
Hedging Set is a group of risk positions from the transactions within a single netting set for which only their balance is relevant for determining the exposure amount or EAD under the CCR standardised method.
Current Exposure
Current Exposure is the larger of zero, or the market value of a transaction or portfolio of transactions within a netting set with a counterparty that would be lost upon the default of the counterparty, assuming no recovery on the value of those transactions in bankruptcy. Current exposure is often also called Replacement Cost.
Credit Valuation Adjustment
It is an adjustment to the mid-market valuation of the portfolio of trades with counterparty. This adjustment reflects the market value of the credit risk due to any failure to perform on contractual agreements with counterparty. This adjustment may reflect the market value of the credit risk of the counterparty or the market value of the credit risk of both the bank and the counterparty.
One-Sided Credit Valuation Adjustment
It is a credit valuation adjustment that reflects the market value of the credit risk of the counterparty to the firm, but does not reflect the market value of the credit risk of the bank to the counterparty.
Default Risk Capital Charge for CCR
The exposure amount for the purpose of computing for default risk capital charge for counterparty credit risk will be calculated using the Current Exposure Method (CEM) as detailed in the Circular.
Capitalization of mark-to-market counterparty risk losses (CVA capital charge)
In addition to the default risk capital requirement for counterparty credit risk, banks are also required to compute an additional capital charge to cover the risk of mark-to-market losses on the expected counterparty risk (such losses being known as credit value adjustments, CVA) to OTC derivatives. The CVA capital charge will be calculated in the manner as indicated in the RBI Circular.
Failed Transactions
(a) With regard to unsettled securities and foreign exchange transactions, banks are exposed to counterparty credit risk from trade date, irrespective of the booking or the accounting of the transaction. Banks may develop and implement suitable systems for tracking and monitoring the credit risk exposure arising from unsettled transactions as appropriate for producing management information that facilitates action on a timely basis.
(b) Banks must closely monitor securities and foreign exchange transactions that have failed, starting from the day they fail for producing management information that facilitates action on a timely basis
(c) Failure of transactions settled through a delivery-versus-payment system (DvP), providing simultaneous exchanges of securities for cash, expose banks to a risk of loss on the difference between the transaction valued at the agreed settlement price and the transaction valued at current market price (i.e. positive current exposure).
(d) For DvP Transactions - If the payments have not yet taken place five business days after the settlement date, banks are required to calculate a capital charge by multiplying the positive current exposure of the transaction by the appropriate factor as given in the Circular. In order to capture the information, banks may upgrade their information systems in order to track the number of days after the agreed settlement date and calculate the corresponding capital charge.
(e) For non-DvP transactions (free deliveries) after the first contractual payment/ delivery leg, the bank that has made the payment will treat its exposure as a loan if the second leg has not been received by the end of the business day.
External Credit Assessment
RBI has identified various credit agencies whose ratings may be used by banks for the purposes of risk weighting their claims for capital adequacy purposes under the revised framework as under:-
(a) Brickwork Ratings India Pvt. Limited (Brickwork);
(b) Credit Analysis and Research Limited;
(c) CRISIL Limited;
(d) ICRA Limited;
(e) India Ratings and Research Private Limited (India Ratings); and (f) SME Rating Agency of India Ltd. (SMERA)
International Agencies (where specified) (d) Fitch
(e) Moodys; and (f) Standard & Poor’s
Banks are required to use the chosen credit rating agencies and their ratings consistently for each type of claim, for both risk weighting and risk management purposes. The revised framework recommends development of a mapping process to assign the ratings issued by eligible credit rating agencies to the risk weights available under the Standardised risk weighting framework. Under the Framework, ratings have been mapped for appropriate risk weights applicable as per Standardised approach. The risk weight mapping for Long Term and Short Term Ratings are given in the Circular.
Credit Risk Mitigation Techniques
Banks use a number of techniques to mitigate the credit risks to which they are exposed. For example, exposures may be collateralised in whole or in part by cash or securities, deposits from the same counterparty, guarantee of a third party, etc. In order for banks to obtain capital relief for any use of CRM techniques, certain minimum standards for legal documentation must be met. All documentation used in collateralised transactions and guarantees must be binding on all parties and legally enforceable in all relevant jurisdictions. Banks must have conducted sufficient legal review, which should be well documented, to verify this requirement. Such verification should have a well-founded legal basis for reaching the conclusion about the binding nature and enforceability of the documents
Few of such CRM techniques are given below:- (d) Collateralized transactions –
– The credit exposure is hedged in whole or part by collaterals by a counterparty (party to whom a bank has an on-or off balance sheet credit exposure) or by a third party on behalf of the counterparty and banks have specific lien over the collaterals
– Under the Framework, banks are allowed to adopt either Simple Approach or Comprehensive Approach.
The former approach substitutes the risk weighting of the collateral for the risk weighting of the counterparty for the collateraised portion of the exposure and under the latter approach which allows fuller offset of collaterals against exposures. Comprehensive approach is being adopted by banks in India.
– In the comprehensive approach, when taking collateral, banks will need to calculate their adjusted exposure to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral.
Hair Cut
In the comprehensive approach, Banks are required to adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either, occasioned by market movements. These adjustments are referred to as ‘haircuts’. The application of haircuts will produce volatility adjusted amounts for both exposure and collateral. The volatility adjusted amount for the exposure will be higher than the exposure and the volatility adjusted amount for the collateral will be lower than the collateral, unless either side of the transaction is cash. In other words, the ‘haircut’
for the exposure will be a premium factor and the ‘haircut’ for the collateral will be a discount factor.
It may be noted that the purpose underlying the application of haircut is to capture the market-related volatility inherent in the value of exposures as well as of the eligible financial collaterals. Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty.
Banks have two ways of calculating the haircuts viz. (i) Standard supervisory haircuts; using parameters set by the Basel Committee, and (ii) Own estimate haircuts, using banks’ own internal estimates of market price volatility.
Banks in India shalluse only the standard supervisory haircuts for both the exposure as well as the collateral.
The Standard Supervisory Haircuts (assuming daily mark-to-market, daily re-margining and a 10 business-day holding period), expressed as percentages, are given in detail in the RBI Circular.
Eligible Financial Collateral in Comprehensive approach
Cash, Gold, Securities issued by Central & State Governments, KVP, NSC (no lock in period is operational), LIC policies, Debt securities (rated by a chosen rating agency), Debt Securities ( not rated by a chosen Credit Rating Agency in respect of which banks should be sufficiently confident about the market liquidity), Units of Mutual Funds, etc. are eligible financial instruments for recognition in the Comprehensive Approach.
Calculation of capital requirement
For a collateralised transaction, the exposure amount after risk mitigation is calculated as follows:
E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]}
Where:
E* = the exposure value after risk mitigation
E = current value of the exposure for which the collateral qualifies as a risk mitigant He = haircut appropriate to the exposure
C = the current value of the collateral received Hc= haircut appropriate to the collateral Hfx = haircut appropriate for currency mismatch between the collateral and exposure
The exposure amount after risk mitigation (i.e., E*) will be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction. (Illustrative examples calculating the effect of Credit Risk Mitigation is furnished in the RBI Circular).
(e) On Balance Sheet Netting –
On-balance sheet netting is confined to loans/advances and deposits. Under this technique, banks have legally enforceable netting arrangements involving specific lien with proof of documentation. Capital requirement is reckoned on the basis of net credit exposure. Banks may calculate capital requirements on the basis of net credit exposures subject to some conditions as listed in the Circular.
(f) Guarantees –
Explicit, irrevocable, and unconditional guarantees may be taken as credit protection in calculating capital requirements. Guarantees issued by entities with lower risk weight as compared to the counterparty will lead to reduced capital charges since the protected portion of the counterparty exposure is assigned the risk weight of the guarantor, whereas the uncovered portion retains the risk weight of the underlying counterparty. Detailed operational requirements for guarantees eligible for being treated as a CRM are given in the RBI Circular.